How Important is the Off-Price Channel in Retail

I have been thinking at the off-price retail market recently, both offline and online. Businesses playing into this market rely on accessing surplus stock from brands, and then selling it down to the end customers at a markup (but still at heavy discounts to RRP). Surplus stock fundamentally exists because of structural inefficiencies in the retail industry which make it difficult for brands to accurately forecast demand (and therefore production): production cycles are long, so brands don’t know if it will be a good season until it’s too late to react. In categories like fashion, where trends are volatile and their lifespan difficult to predict, this factor is even more important: fear of missing out forces brands to deliberately over-produce.

One key question from the investor’s perspective is whether these structural imperfections will at some point go away, as brands become increasingly good at forecasting demand.  That would obviously reduce the economic need for off-price retailers, as in a perfect retail marketplace brands should be able to sell 100% of their inventory at full price.

So I looked at the US market, where more data is available on listed off-price retailers. I specifically looked for evidence of low / decreasing importance of off-price retailers in the retail value chain (in my mind low was <5% of the entire market, a completely arbitrary low number). I was therefore surprised to find that the basket of six off-price retailers I used in my analysis contributed to 16.3% of the US Clothing & Clothing Accessories market in 2012, up from 12.9% in 2005. I looked at the clothing and accessories market as off-price retailers tend to mainly sell that.

US Clothing & Clothing Accessories Market

Note: off-price include TJX, Ross Stores, Big Lots, Stein Mart, Overstock, Bluefly.

Source: companies accounts, US Census

This is even more impressive if one thinks that those off-price sales occurred at c. 50% discount to full retail price, so in terms of volumes the importance of off-price retailers in this category is enormous.

My analysis is deliberately conservative as it is excluding all privately-owned off-price retailers which I could not easily get revenue data for. These include large online off-price retailers such as Gilt, RueLaLa, HauteLook etc which experienced very high growth over the period I looked at and certainly would add % points to the 16.3% number I got to and steepness to the red curve.

What this is suggesting is that surplus stock is unlikely to go away from the industry any time soon and, if anything, brands should be feeling more comfortable in their over-production decision because of the efficiency of these channels in clearing up their unsold stock.

What this is not showing though is the impact on margins that this channel has for the brands…

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